Argentina fell victim to market turbulence after 10-year U.S. swap rates rose from 2.4% at the start of the year to 3.0% in May and the dollar strengthened against nearly every other currency on the globe. Argentina always was going to be held hostage by foreign investors given its high reliance on foreign funding and its high fiscal deficit (-6.5% in 2017). However, the speed by which markets imploded took the government by surprise. The country’s central bank was forced to increase local interest rates by 12.75% to 40% in a time span of 10 days and spent USD 5 billion in FX reserves in order to stabilize the market. The peso depreciated by nearly 30% this year as the sell-off in the currency gathered speed in early May, whilst in mid-May credit markets factored in a probability of sovereign default of 25% within 5 years (10% higher than at the start of the year). Given the fact that the government faced significant short-term refinancing needs (USD 25 billion in so-called Lebacs fell due on May 15th), President Macri had no other option than to announce (on May 8th) that the government would request a credit line to the IMF.
Enemy or savior of the State…?
The government is largely to blame for the rout, although having to finance a twin deficit by foreign money is a catch-22 because if you are successful in doing so your currency tends to appreciate (making the economy less competitive). After winning the mid-term elections in October of last year, Macri should have sped up his reform plans (especially those related to labour and raising of productivity) and reduce government spending to rein in the fiscal deficit more quickly (which we believe was politically not possible from the start in December 2015). Also, the ubiquity of Marco Peña, the chief of cabinet, in BCRA meetings did not fortify investors’ perception of the central bank’s independence. And trying to uphold the value of the peso by spending reserves is a futile (or stupid) game. However, as we have said in previous blogs, Macri’s government is implementing sensible policies which eventually will deliver sustainable economic growth and which deserves support. The IMF was quick to realize this point and understood that decisive action was needed. Hence, within a record 4-week time period the IMF agreed to an USD 50 billion 3-year stand-by arrangement, of which 30% can immediately be drawn down after IMF Board approval. Loan tranches have a 5-year maturity with 3-year grace period and an attractive coupon of less than 5%. This package easily addresses Argentina’s financing needs for this and next year. The size of the credit line was at the upper end of the range of what market analysts were expecting. Furthermore, the IMF package comes with sensible conditions: a faster fiscal consolidation (with a primary deficit target of -2.7% this year, -1.3% next year and 0% in 2020), enshrining central bank independence in law (no more direct lending to the Treasury) and adopting a floating exchange rate regime (i.e. no more wasting of reserves to defend the peso). So, the IMF, not being the most popular institution in Argentina after the 2001 sovereign debt debacle, clearly supports Macri, allowing for a gradual fiscal adjustment (albeit at a faster pace) and (politically very important) communicating that the Macri government remains in charge and not the IMF. To sum it up: Ms. Lagarde did a terrific job.
Macri’s job remains very challenging, to say the least. The government will need support in Congress to pass a tight(er) budget for 2019, which is only feasible by reducing discretionary transfers to provinces as well as other freebies and by scaling back public infrastructure works. Economic growth will probably suffer as a result of high interest rates and lower private investment: J.P. Morgan forecasts 1.5% this year and 2.1% for 2019. The recent woes affecting Argentina’s most important trading partner, Brazil (good for 16% of exports), which actually is in a much worse shape than Argentina, obviously doesn’t help. It is not likely that Macri will win the popularity price (the Peronists will try to capitalize on his decision to call the IMF) and this could form a hurdle to Macri’s re-election as president in October next year. Let’s hope the Argentine people remember the misery after the default in 2001 and rally behind Macri’s government (for example, by not holidaying abroad but instead invest the money in businesses at home) to stave off a similar fate this time around.
